Disasters , Hybrids and Weed: Special Legal Issues for Appraisers

1. Disasters, Hybrids and Weed:Special Legal Issues for Appraisers Seattle Chapter of the Appraisal Institute April 25-26, 2019 Peter T. Christensen LIA Administrators & Ins. Services Santa Barbara, CA www.liability.com 800-334-0652 peter@liability.com

2. Where Are We Going This Morning? • Begin with an overview key appraiser professional liability issues. • Then, talk about real-world liability and disciplinary risks relating to: • Appraisals following a natural disaster such as fire or flood. • Hybrid appraisal products. • Marijuana cultivation activities.

3. Appraiser Liability ClaimsWhat Are We Generally Talking About? Elements of a professional negligence legal claim? Legal duty owed by the defendant appraiser to the plaintiff to follow a certain professional standard of care, The defendant appraiser’s breach of that standard of care, and An injury to the plaintiff proximately caused by the breach.

4. So Who Can Sue an Appraiser for Negligence?To Whom Does an Appraiser Owe a Legal Duty? • The client, of course. • Other parties? • In most states, the case law uses a test along the following lines: “Did the professional know or reasonably expect that the third party would use or rely on the information being supplied by the professional.”

5. RockRock Group v. Value Logic, WA Court of Appeal Opinion Published July 7, 2016 • In mid-2006, a real estate developer had two adjacent properties near Spokane under contract for $475,000 and $300,000. • One property was 51 acres; the other was 39 acres. • Both were zoned partially “light industrial” and partially “rural traditional” (a classification permitting minimal use). • The developer was seeking to flip the properties to other investors. • LLCs were formed through which the purchases would be made with financing from RiverBank. • RiverBank engaged Value Logic to appraise the properties – the fees paid were $3,000 and $2,000. • The appraisals, delivered in October 2006, valued the properties at $4,500,000 and $4,250,000.

6. RockRock Group v. Value Logic, WA Court of AppealOpinion Published July 7, 2016 • The reports contained the following limitations:

7. RockRock Group v. Value Logic, WA Court of Appeal Opinion Published July 7, 2016 • The developer received copies of the appraisals and showed them to prospective investors. • Some of the investors received copies. • The developer’s pitch was that the investor LLCs would be able to flip their interests quickly – the investors purportedly did not know that the developer had the properties under contract for far less than they were paying. • Statements were made by the developer to investors such as: “with the appraisals I got . . . an idiot could get into these properties and make a quarter million dollars.”

8. RockRock Group v. Value Logic, WA Court of Appeal Opinion Published July 7, 2016 • The investor LLCs – one named RockRock Group and the other RussellRock Group – purchased 75% interests in the properties. • RockRock paid $1.8m for its interest in the 53-acre property; RussellRock paid $1.63m for its interest in the smaller property. • RiverBank financed the purchases based on the appraisals and with personal guarantees from the investors in each LLC. • After acquiring their interests, RockRock and RussellRock were not successful in re-flipping the properties themselves. The market tanked almost immediately after the purchases were complete. • In 2009, payments came due on the loans, defaults occurred, and the investors were called on their guarantees.

9. RockRock Group v. Value Logic, WA Court of Appeal Opinion Published July 7, 2016 • In 2011, RockRock and RussellRock sued Value Logic, LLC and its two appraisers. • The gravamen of the complaint was that Value Logic negligently overvalued the properties in 2006 and that the LLCs would not have completed the purchases but for the overstated values. • The primary theory was negligent misrepresentation. • The damages demanded by the plaintiffs exceeded $5,000,000.

10. RockRock Group v. Value Logic, WA Court of Appeal Opinion Published July 7, 2016 • Value Logic moved for summary judgment, which was granted by the trial court on the basis that Value Logic did not owe the investors a legal duty. The WA Court of Appeals affirmed the judgment. • Why? The language about intended use and user was the key.

11. “What Can I Do?” • Include a specific advisory in reports directed to purchasers/borrowers and sellers. Example: • “The appraiser has not identified any purchaser, borrower or seller as an intended user of this appraisal and no such party should use or rely on this appraisal for any purpose. Such parties are advised to obtain an appraisal from an appraiser of their own choosing if they require an appraisal for their own use. This appraisal report should not serve as the basis for any property purchase decision or any appraisal contingency in a purchase agreement relating to the property.” • Every report should be as clear and narrow as possible as to who the intended user is and what the intended use is.

12. Good Intended Use and User Language If the appraisal is for a divorce, say something like this instead: The intended use of this appraisal is to provide the client in this report with an opinion of the market value of the subject property for the client’s sole use in contesting the division of assets in the client’s marital dissolution proceeding. The appraiser does not intend, know of or authorize any other use of this appraisal or content in this report. The appraisal and content of this report should not be used for any other purpose.

13. Appraising After a Natural Disaster • U.S. has experienced record-breaking weather-related disasters. In 2017, for example, 16 separate weather events each resulted in more than $1 billion in losses. • The monetary damages in 2018 caused by just two wildland fires in California – the Camp Fire in Northern California and the Woolsey Fire in Southern California – are estimated to exceed $20 billion. • Following a disaster, appraisal work is needed, and it is performed – are there any special liability issues to think about?

14. Appraising After a Natural Disaster • Are there claims and lawsuits against appraisers in relation to such events? • Many appraisers are specifically trained to help respond after disaster strikes. • They may work with FEMA or other federal agencies, or they may assist in determining losses for insurance or tax purposes. • We do not see appraisers face professional liability claims from this kind of disaster-specific work in any significant volume. • What we do sometimes see are liability claims relating to the “regular” appraisal work performed in the wake of a disaster: • Appraisal for a lender/client to appraise a property immediately after a disaster for new loan or for other lending purposes, or • Re-inspect or re­certify the value of a property that was appraised before the disaster.

15. A Real-World Claim Situation: Accused of Failing to Detect Structural Damage Following a Flood • In a recent claim situation, an appraiser originally had performed a purchase loan appraisal of a single-family residence for a regular client. This assignment had included customary interior and exterior inspections and was reported on a standard Uniform Residential Appraisal Report form. • About a year later, the same lender called the appraiser back to do a drive-by appraisal for refinance. • Within a few months, the area suffered severe flooding that damaged hundreds of homes. The borrower defaulted, and the lender foreclosed. • The lender then asked the appraiser to do another drive-by appraisal for its use in the foreclosure. • Given the recent flooding, the lender stated that it wanted the appraiser to comment, specifically, on whether the property showed "any evidence of exposure to recent flooding that affected the area."

16. A Real-World Claim Situation: Accused of Failing to Detect Structural Damage Following a Flood • The appraiser was uncomfortable. The lender told the appraiser to "do his best.” • The lender was a long-time client, and the appraiser didn’t want to walk away. However, he did not want to take on a needless liability exposure either. • In this report, the appraiser took the time to add a brief description of the flooding in the area. • He explained in the report that, while the property was located in an area impacted by flooding, there did not appear to be any visible, external evidence that flood water had actually touched the structure, such as visible mud or water stains. • Though he only included the standard photos for this type of assignment in the report itself, he did take a few minutes extra to take some additional photos of the property – which he fortunately retained.

17. A Real-World Claim Situation: Accused of Failing to Detect Structural Damage Following a Flood • Some months later, after completion of foreclosure, the lender’s attorneys threatened the appraiser with a legal claim. • The lender had acquired the property at the foreclosure auction for its loan amount, rather than let a bidder purchase it for less. Shortly thereafter, a major portion of the roof and ceiling had collapsed into the house. • The lender demanded to know why the appraiser had failed to report the structural problems and demanded that the appraiser compensate the lender for the cost to repair. • The appraiser was angry with the lender for trying to place blame on him, but still wanted to maintain the client relationship for the long term. He drafted a letter explaining his initial hesitancy to complete the assignment. He highlighted the language he had added to his report about only inspecting visible areas. He included copies of the extra photos he had taken which did not depict anything wrong with the structure or with the roof.

18. A Real-World Claim Situation: Accused of Failing to Detect Structural Damage Following a Flood • After sending in this response, the appraiser heard nothing further from the lender until he later received an assignment to perform another new appraisal. • The lender never officially abandoned the claim, but never mentioned anything further about it and never filed a lawsuit. (That’s just the way some claims die – no climactic ending.) • The appraiser continued to receive assignments and we closed the claim file. • That’s the power of plain English. Just say it in the report.

19. Key Liability Prevention Measures for Appraising After a Natural Disaster • The appraiser in the flood related claim did everything right to avoid liability: • he took the time to take a few extra photos – which he retained for his own protection, and • he added a plain English description of the disaster in his report, included an advisement about the limits of his inspection. • For other assignments that involve a fuller inspection, here is the type of language that we would recommend appraisers consider: • Appraiser is not a building inspector, contractor or engineer. Appraiser conducted a visual inspection of only the accessible areas. Appraiser makes no guarantees about the structural integrity of the property and assumes no adverse conditions exist. An expert should be consulted and further inspection conducted if there are any concerns about structural integrity.

20. Key Liability Prevention Measures for Appraising After a Natural Disaster • If damage is detected during the inspection, the appraiser should: • specifically describe what they have observed, • consider whether the appraisal should be “subject to” repair, and • and take and provide extra photos. • We’ve never defended a case against an appraiser in our insurance program in which we, the defense attorneys or the defense appraisal expert felt the appraiser took too many photos.

21. Hybrid Appraisal Risks • Appraisals that combine appraiser’s valuation analysis with another party’s inspection and/or with AVMs or automated tools. • Main liability concerns: • Appraiser (and AMC) may be dragged into claim – typically by borrower – based on information supplied by the other parties. • Clarity of who provides and is responsible for particular information alleviates some of the liability risk.

22. Hybrid Appraisal Risks • Main liability concerns (cont’d): • Some of the new products are missing liability prevention ingredients. Key examples: • No statements that the report is not a home inspection. • Weak wording on intended use and intended user. • The worst forms just copy 1004 language. • As a general matter, many form designers don’t take advantage of their freedom from the 1004 – they are not doing a good job in reducing potential liability not only for the appraiser, but also for their own companies and inspectors.

23. Hybrid Appraisal Risks • Main liability concerns (cont’d): • In performing certain hybrid appraisals, appraisers may: • Rely too heavily on automated tools built into the software platforms that create the reports. • Fail to create an adequate work file with the required information and data to support (and perhaps later defend) their appraisal. • As far as liability and disciplinary risk, there is a big distinction between a hybrid valuation that a consumer may receive a copy of, versus one that will strictly be used internally.

24. Hybrid Appraisal Risks • Problem: Inspectors vary widely in qualifications. • No standards for the inspectors. • May or may not be named in report. • May or may not be insured. • My observation is that inspection work for these purposes is usually a short term, non-career work experience and usually for pay below long term livability.

25. Hybrid Appraisal Risks Since there are no industry-entrenched hybrid appraisal forms yet, an appraiser might see each new hybrid form as a blank canvas on which to use his or her own protective language. In that regard, keeping in mind that 60+% of claims come from borrowers/purchasers, you might consider using language like this in the form: The appraiser has not identified any borrower, purchaser or seller as an intended user of this appraisal and no such party should use or rely on this appraisal for any purpose. Such parties are advised to obtain an appraisal from an appraiser of their own choosing if they require a valuation for their own use. This appraisal report should not serve as the basis for any property purchase decision or any appraisal contingency in a purchase agreement relating to the property. No information in this report or utilized by the appraiser about the characteristics or condition of the property should be considered a home or property inspection. Any party using or relying on this report, whether authorized or not by the appraiser, acknowledges and agrees that the appraiser has no liability or other responsibility for any matter relating to the characteristics or condition of the property or other matters reported by any third party.

26. Hybrid Appraisal Risks The question most often posed by appraisers to LIA (as an E&O provider) about hybrid valuations: • “Am I covered by my E&O policy for doing them?”

27. What about this situation?

28. What about this situation? • Informal poll: • In the last five years, who has ever appraised a marijuana-specific property (greenhouse, processing facility, distribution location, etc.) for the purpose of a loan? • In the last five years, who has ever seen marijuana on a property while appraising a property of any type? • What does that tell us?

29. Why Banks Generally Won’t Bank with Marijuana Businesses • Under federal law, marijuana is still classified as a Schedule I controlled substance under the Controlled Substances Act (CSA). • Classified as Schedule 1 under the following criteria: • The drug has a high potential for abuse. • The drug has no currently accepted medical use in treatment in the United States. • There is a lack of accepted safety for the use of the drug under medical supervision. • Other Schedule I drugs: Heroin, LSD, Ecstasy. • Schedule II Drugs: Cocaine, OxyContin, Methamphetamine, Morphine, Opium.

30. Why Banks Generally Won’t Bank with Marijuana Businesses • Banks do not want to be implicated as money-launderers. • Required to file SAAR reports. • In February 2014, the Treasury Department and the DOJ issued guidelines intended to increase financial services available to marijuana businesses. • The banking industry didn’t bite. They want an Act of Congress to pass legislation to provide certainty that financial institutions can engage with marijuana businesses • “While we appreciate the efforts by the Department of Justice and FinCEN, guidance or regulation doesn’t alter the underlying challenge for banks. . . As it stands, possession or distribution of marijuana violates federal law, and banks that provide support for those activities face the risk of prosecution and assorted sanctions.” • – Frank Keating, president, American Bankers Association.

31. Always Watch for Peak Prices in a Bubble Many of the hardest appraisals to defend are those that appraisers did just after the peak of the bubble. • Failing to react to the peak despite obvious signs. • Using older and older comps, without time adjustment, to support the value. • There have been some local bubbles in commercial real estate for marijuana facility use. • Values crashed in micro-markets when land use plans changed in the local political environment. • Adjacent property owners pushing for change. • Different personalities on a county board of supervisors or city government.

32. Example of a Local Regulatory Disaster • In 2016, thinking it was getting a jump on competition from other counties for future business, Calaveras County passed a local ordinance allowing marijuana growers to apply for permits in the county. • County voters also approved Measure C, a cultivation tax. • Growers flocked to the county, purchased the right properties in the permitted areas and made investments. • Prices increased on certain types of properties. • The county also collected nearly $12 million in permit fees and taxes from growers. • But when a shakeup of the Board of Supervisors occurred, the Board authorized that an Environmental Impact Report (EIR) be conducted and as a result of the EIR, the board summarily banned all commercial cannabis operations in the county.

33. So, what about this situation? What should the appraiser do on regular lending appraisal?

34. Use Plain English Disclosures Example disclosure: “The appraiser observed approximately 60 plants believed to be marijuana growing in the basement under lighting strung from bare wires suspended from ceiling. See photos from basement.”